Markets in a Minute
The Effects of Quantitative Tightening: Less Liquidity, More Volatility
This infographic is available as a poster.
This infographic is available as a poster.
Quantitative Tightening: Less Liquidity, More Volatility
How are interest rate hikes and quantitative tightening affecting markets?
The Federal Reserve’s fast-paced rate hikes and initial reductions of its balance sheet have resulted in liquidity drying up across markets, amplifying volatility and uncertainty.
This Markets in a Minute from New York Life Investments explains how quantitative tightening affects markets, and charts the rise in volatility spurred by the severe decline in S&P 500 futures book depth.
What is Quantitative Tightening (QT)?
Quantitative tightening (QT) is the infamous twin to quantitative easing (QE). For context, quantitative easing is the injection of liquidity into bond markets by the Federal Reserve buying Treasuries and mortgage-backed securities which are added onto the Fed’s balance sheet.
As a result, during periods of quantitative easing, Treasuries and certain mortgage-backed securities have a large-scale buyer providing buy-side liquidity, reducing the impact of sellers in the market. This supports bond prices, and prevents bond yields from rising too quickly.
Quantitative tightening is a reduction of the assets on the Federal Reserve’s balance sheet. This means letting Treasuries mature and not rebuying them, or even selling them on the market. Opposite to quantitative easing, QT removes buy-side liquidity from the market and can result in bond prices falling and yields rising.
How Rate Hikes and Quantitative Tightening Affect Markets
Along with quantitative tightening’s reduction of liquidity from markets, interest rate hikes can also result in less market liquidity.
As interest rates rise, so do borrowing costs for capital. This results in less money being lent out and fewer deals being funded, higher mortgage and other loan rates, and tighter overall purse strings of market participants and everyday consumers. In this way, higher interest rates slow down market and economic activity.
The Fed’s pace of rate hikes in 2022 has been one of the fastest in history, with the Federal Funds rate starting the year at 0.0-0.25% and projected to end the year somewhere between 4.0-4.5%.
| Date | Change in Rates (bps) | Federal Funds Rate |
|---|---|---|
| March 2022 | +25 | 0.25-0.50% |
| May 2022 | +50 | 0.75-1.00% |
| June 2022 | +75 | 1.50-1.75% |
| July 2022 | +75 | 2.25-2.50% |
| September 2022 | +75 | 3.00-3.25% |
Source: Federal Reserve
As rates have continued to rise, the rate of quantitative tightening doubled in September to now let a maximum of $60 billion of Treasuries and $35 billion of mortgage-backed securities roll off its balance sheet without repurchase.
This acceleration in QT could see market liquidity dry up even more, further amplifying volatility.
How Low Liquidity and High Volatility Raise Risk
One of the clearest measures of liquidity is a market’s book depth. Book depth is the amount of available buy and sell orders in a market’s order book.
More orders stacked up on either side results in thicker book depth, or deeper liquidity for incoming buy and sell orders to tap into, while less orders on either side result in thinner book depth, especially at the top of the book.
The top of the book is where buy and sell orders are closest to the last traded price:
- $101 – Closest sell orders
- $100 – Current/last traded price
- $99 – Closest buy orders
In the example above, buy orders at $101 and sell orders at $99 are at the top of the order book since they are closest to the last traded price.
As liquidity tightens and book depth thins out, orders at the top of the book become smaller, meaning that prices can move around more easily as big trades come into the market to fill orders at the top of the book.
In this way, tighter liquidity and thinner book depth result in higher volatility, largely raising risk for market participants. This can turn into a self-reinforcing cycle, as investors sit out of the markets to avoid periods of high volatility, resulting in even less liquidity and higher volatility.
Looking Ahead
As book depth has thinned out significantly over the past year, volatility began to rise alongside the market’s uncertainty.
With more rate hikes incoming and the Fed’s QT operations continuing at a faster pace now, market participants may brace for even less liquidity in markets and the possibility for further volatility and heightened risk.
Markets in a Minute
The Average American’s Financial Portfolio by Account Type
From retirement plans to bank accounts, we show the percentage of an American’s financial portfolio that is typically held in each account.
The Average American’s Financial Portfolio by Account Type
Where does the average American put their money? From retirement plans to banks, the typical financial portfolio includes a variety of accounts.
In this graphic from Morningstar, we explore what percentage of a person’s money is typically held within each account.
Breaking Down a Typical Financial Portfolio
People put the most money in employer retirement plans, which make up nearly two-fifths of the average financial portfolio. Bank accounts, which include checking, savings, and CDs, hold the second-largest percentage of people’s money.
| Account Type | % of Financial Portfolio |
|---|---|
| Employer retirement plan | 38% |
| Bank account | 23% |
| Brokerage/investment account | 14% |
| Traditional IRA | 10% |
| Roth IRA | 7% |
| Crypto wallet/account | 4% |
| Education savings account | 3% |
| Other | 1% |
Source: Morningstar Voice of the Investor Report 2024, based on 1,261 U.S. respondents.
Outside of employer retirement plans and bank accounts, the average American keeps nearly 40% of their money in accounts that advisors typically help manage. For instance, people also hold a large portion of their assets in investment accounts and IRAs.
![Three pages with data visualizations that are zoomed out so they arent fully readable along with the text](https://advisor.visualcapitalist.com/wp-content/uploads/2024/09/In-article-ad.png")
Account Insight for Advisors
Given the large focus on retirement accounts in financial portfolios, advisors can clearly communicate how they will help investors achieve their retirement goals. Notably, Americans say that funding retirement accounts is a top financial goal in the next three years (39% of people), second only to reducing debt (40%).
Americans also say that building an emergency fund is one of their financial goals (35%), which can be supported by the money they hold in bank accounts. However, it can be helpful for advisors to educate clients on the lower return potential of savings accounts and CDs. In comparison, advisors can highlight that investment or retirement accounts can hold assets with more potential for building wealth, like mutual funds or ETFs. With this knowledge in mind, clients will be better able to balance short-term and long-term financial goals.
The survey results also highlight the importance of advisors staying up to date on emerging trends and products. People hold 4% of their money in crypto accounts on average, and nearly a quarter of people said they hold crypto assets like bitcoin. Advisors who educate themselves on these assets can more effectively answer investors’ questions.
Markets in a Minute
5 Factors Linked to Higher Investor Engagement
Engaged investors review their goals often and are more involved in decisions, but which factors are tied to higher investor engagement?
5 Factors Linked to Higher Investor Engagement
Imagine two investors. One investor reviews their investment goals every quarter and actively makes decisions. The second investor hasn’t reviewed their goals in over a year and doesn’t take part in any investment decisions. Are there traits that the first, more involved investor would be more likely to have?
In this graphic from Morningstar, we explore five factors that are associated with high investor engagement.
Influences on Investor Engagement
Morningstar scores their Investor Engagement Index from a low of zero to a high of 100, which indicates full engagement. In their survey, they discovered five traits that are tied to higher average engagement levels among investors.
| Factor | Investor Engagement Index Score (Max = 100) |
|---|---|
| Financial advisor relationship | Don’t work with financial advisor: 63 |
| Work with financial advisor: 70 | |
| Sustainability alignment | No actions/alignment: 63 |
| Some/full alignment: 74 | |
| Trust in AI | Low trust: 61 |
| High trust: 74 | |
| Risk tolerance | Conservative: 62 |
| Aggressive: 76 | |
| Comfort making investment decisions | Low comfort: 42 |
| High comfort: 76 |
Morningstar’s Investor Engagement Index is equally weighted based on retail investors’ responses to seven questions: feeling informed about composition and performance of investments, frequency of investment portfolio review, involvement in investment decision-making, understanding of investment concepts and financial markets, frequency of goals review, clarity of investment strategy aligning to long-term goals, and frequency of engagement in financial education activities.
On average, people who work with financial advisors, have sustainability alignment, trust AI, and have a high risk tolerance are more engaged.
The starkest contrast was that people with high comfort making investment decisions have engagement levels that are nearly two times higher than those with low comfort. In fact, people with a high comfort level were significantly more likely to say they were knowledgeable about the composition and performance of their investments (84%) vs. those with low comfort (18%).
Personalizing Experiences Based on Engagement
Advisors can consider adjusting their approach depending on an investor’s engagement level. For example, if a client has an aggressive risk tolerance this may indicate the client is more engaged. Based on this, the advisor could check if the client would prefer more frequent portfolio reviews.
On the other hand, soft skills can play a key role for those who are less engaged. People with low comfort making investment decisions indicated that the top ways their financial advisor provides value is through optimizing for growth and risk management (62%), making them feel more secure about their financial future (38%), and offering peace of mind and relief from the stress of money management (30%).
The Average American’s Financial Portfolio by Account Type
5 Factors Linked to Higher Investor Engagement
The Top 5 Reasons Clients Fire a Financial Advisor
The Top 5 Reasons Clients Hire a Financial Advisor
Visualizing the Growth of $100, by Asset Class
-
Markets in a Minute3 years agoMapped: The Growth in U.S. House Prices by State
-
Markets in a Minute2 years agoHow Closely Related Are Historical Mortgage Rates and Housing Prices?
-
Infographics2 years agoA Visual Guide to Stagflation, Inflation, and Deflation
-
Markets in a Minute2 years agoMapped: Global Energy Prices, by Country in 2022
-
Infographics2 years agoVisual Guide: The Three Types of Economic Indicators
-
Markets in a Minute2 years agoVisualizing 90 Years of Stock and Bond Portfolio Performance
-
Markets in a Minute2 years agoVisualizing Every Company on the S&P 500 Index
-
Markets in a Minute2 years agoMapped: Global Macroeconomic Risk, by Country in 2022
